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Comment by toss892625 | Hacker News Reader

Reducing the free loan you provide to a bank with a checking account is good, but be very careful with leverage. IMO any leverage should be a very deliberate decision.

If you buy a 30k car/tuition one day (depending on how much you have invested, this could be a lot of leverage!), and the market crashes by 50% the next day, would you be ruined? It's possible that even if the stock immediately recovers from some flash crash, you'll have insufficient collateral and the positions will be closed. (Locking in huge losses at the worst time during some irrational panic)

EDIT:

I suppose this is no more risky than buying something on a credit card, then selling a stock to pay off the card after a month. Still, Schwab can't get your credit card balance and close a position in real time, whereas they can with this leverage strategy.

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You definitely raise a valid point, but as I mentioned in reply to a sibling comment, I do try to prepare in advance for big purchases like those by selling off stocks to pay those off in cash. I would never deliberately use margin as a financing option due to those dangers you mentioned.

Your scenario meets the definition of 'using margin as a financing option'. It is the same as the overdraft option provided by credit cards, only it is more dangerous since in the margin call scenario they actually liquidate your stocks without asking you (if I recall from reading up on how this works at most discount brokerages a few years ago). The fact that you rarely do it helps some but as we know the thing about rare events is they happen every day :). I have held myself to a "current ratio" of over two, which is considered 'healthy' by most finance people when evaluating businesses. I would encourage everyone to calculate their current ratio and make sure it is ALWAYS over two as well. It's literally the current assets (cash you could get access to in a year) divided by the current liabilities (all expenses due in a year). Easy to calculate and immensely freeing once you decide it's a rule you'll never break.

Small point but I think you might mean Liabilities divided by Assets = 2. (aka the 6 month rule)

> It's literally the current assets (cash you could get access to in a year) divided by the current liabilities (all expenses due in a year)

Essentially you should have a 6 month runway. If you have 25K cash and 50K costs per year then the $25K will buy you 6 months to get yourself over a layoff/health issue/etc.

Just a small point because it's a rule I live by and you freaked me out for a moment thinking the advice/goalposts had move way beyond what I've saved for.

thanks

No, the numerator is current assets and the denominator is liabilities. This way if you have half of what you are about to spend in a year, your ratio is .5. If you have double what you are about to spend in a year, your ratio is 2. In your example, your current ratio is .5. Still you are doing way better than most people I know and the stats on national savings and lifestyle requirements bear this out as well.

If the market crashed by 50 percent in a day, I think defaulting on a car loan would be the least of his/your/our worries.

The problem is that there is no car loan in this case; he's paying for the car in cash, and borrowing in the investment account instead.

In both scenarios, let's say we have 60k in stocks to start.

Starting point: 60k stocks

Scenario A: 1 car, (30k car loan), 60k stocks

Scenario B: 1 car, 60k stocks, (30k debt in margin account)

Let's say the market drops by 50%, then recovers by 100% overnight.

At midnight:

Scenario A: 1 car, (30k car loan), 30k stocks

Scenario B: 1 car, 30k stocks, (30k debt in margin account)

Position is closed, so now Scenario B is: 1 car

In the morning, the world goes back to normal:

Scenario A: 1 car, (30k car loan), 60k stocks

Scenario B: 1 car

While we had the same amount of debt in both cases, in scenario A, there's no instant way for the car loan provider to instantly declare that you don't have liquidity at midnight.

> I suppose this is no more risky than buying something on a credit card, then selling a stock to pay off the card after a month.

It's definitely more risky than that. With the credit card strategy your maximum loss is whatever the interest rate on the credit card is. The stock market could drop by a much larger amount.

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